Passive Investing in Multifamily Real Estate Part Four

Part Four: Advantages and Disadvantages of Passive Investing

We’ve come to the last part in our series on passive investing in multifamily real estate. Part one was an introduction to the basics of passive investing, single-family versus multifamily real estate properties, and multifamily syndication. In part two, we looked at the three ways multifamily real estate generates passive value: periodic cash flow, appreciation, and tax benefits. Part three explained in detail the four steps needed to secure your first deal.

Part four addresses the wider picture of passive investing in multifamily real estate. As with any type of investment, passive investing in multifamily real estate has its share of advantages and disadvantages. I’m a firm believer that the advantages far outweigh the disadvantages – but passive investing in multifamily isn’t for everyone. Understanding these advantages and disadvantages will make you a more sophisticated investor, whether this is your first or fiftieth multifamily deal.

Advantages of Passive Investing in Multifamily Real Estate

As a multifamily real estate investor, I see time and time again just how powerful multifamily real estate can be as an investment class. While there are many advantages to passive investing in multifamily real estate, I’ve selected the top six.

1. No day-to-day involvement
2. Cash flow
3. Tax benefits
4. Capital preservation and inflation hedge
5. Build real wealth
6. Favorable risk calculations

#1 – No Day-to-Day Involvement

I firmly believe that most investors are suited to either active or passive involvement in a property. Investors find themselves in trouble when investing in a style unsuited to their needs. In multifamily real estate, some investors enjoy the process of being an owner/operator, or otherwise involved in the day-to-day operations of the unit. Owners often end up managing the property as a DIY landlord. For some, this is both a cash trap and a time sink.

Passive investing in multifamily real estate means you skip the tenets, toilets, and trash problems of property management. You can focus your energy on what matters most: selecting the best property and the best investment partners.

#2 – Cash Flow

Unlike many investments, passive multifamily real estate investments yield cash flow for the duration of the investment. Investors working with syndicates generate passive income through a preferred return. This preferred return is an agreed-upon percentage of the initial investment paid periodically. This can be compared to a stock dividend or interest payments on a bond. This residual income is a big driver in what makes multifamily real estate so attractive.

#3 – Tax Benefits

Beyond cash flow, the tax benefits are a critical component that affects the overall profitability of an investment portfolio. Passive investing in multifamily real estate offers unique tax advantages that add up. Investors are often unaware that their syndicate investment will generate substantial tax benefits. Income distributions can be tax-free when treated as a return of capital. Depreciation can also be used to reduce an overall annual tax burden. Last, profits post-sale can often avoid taxation when applied to a sponsor’s next deal.

#4 – Capital Preservation and Inflation Hedge

Many investors, especially those approaching retirement or those already retired, will adopt a more conservative investment strategy. The goal is to protect portfolio assets and avoid loss. Hedging against inflation is one important tool in preserving capital. Historically, real estate investments have been the most effective way to preserve wealth. Capital invested in physical property is resistant to market fluctuations, and both rents and property value increase as inflation rises.

#5 – Build Real Wealth

Real wealth is built over the long-term. In passive multifamily real estate investing, this happens through capital appreciation. Not only are you generating regular income distributions, but you get access to key tax benefits and, at the end of the sale, a return on your investment. Instead of converting your time into wages, your time can be spent selecting multifamily investments that grow your portfolio.

#6 – Favorable Risk Calculations

Calculating risk for any given investment is a key component in determining projected profitability. Multifamily real estate investing through a syndicate offers a unique case in assessing risk. While there are many types of risk, such as market and asset-level risk, syndication risk tends to carry the most weight. Syndication risk is highly correlated with sponsor experience level. The more experienced a sponsor, the more likely the property will be profitable. Your job as a passive investor is to find and assess the best sponsor, one with an exemplary track record and strong references.

Disadvantages of Passive Investing in Multifamily Real Estate

Passive investing in multifamily real estate isn’t for everyone. Before you begin investing, make sure to consider these potential hazards. You may find that you are better suited to active investing in multifamily real estate instead.

1. Lack of direct control in the property
2. Lack of liquidity
3. Subject to housing market fluctuations
4. Often accredited investors only

#1 – Lack of Direct Control in the Property

Some investors like to roll up their sleeves and to be in the day-to-day management of multifamily real estate. Passive investing requires a certain kind of trust in the syndicate and sponsor. I’ve met many investors who don’t easily trust the judgment of a qualified sponsor. Passive investing requires that you give up direct control of the day-to-day management of the property.

#2 – Lack of Liquidity

Investing in a multifamily real estate syndicate can tie up capital for three, five, seven or ten years or more. Investors who need to exit a syndicate early will need to speak with the sponsor to negotiate a deal or create a loan. This may be at a steep penalty. Investors who need access to liquid capital may be better served with other investment types.

#3 – Subject to Housing Market Fluctuations

Market conditions play a large role in the operations and investment potential of multifamily real estate properties. A typical syndication deal may anticipate a timeline of five years, but unforeseen market conditions may require adjusting the deal structure. It may ultimately take six or seven years to sell the property within the profit targets of the syndicate.

#4 – Often Accredited Investors Only

Multifamily real estate investing often requires considerable capital to be successful. This means that many syndicates will restrict investment to accredited investors. Accredited investors are those with a net worth of at least $1,000,000 and an annual (individual) income of $200,000 for the past two years. These restrictions can be burdensome for many investors that may have considerable wealth, but not enough to qualify for accredited investor status.

Is Passive Investing in Multifamily Real Estate Right For You?

I’ve made a strong case in this series for the benefits of passive investing in multifamily real estate. If you are on the fence, I recommend you reach out to me for a more in-depth conversation. Thank you for reading.